2.

7 Applications of Derivatives to Business

and Economics

Our textbook tells us that business analysts and

economists have increasingly turned to
mathematical models to help them describe what is
happening, predict the effects of various policy
alternatives, and choose reasonable courses of
action.
The derivative is one of the mathematical tools
employed by economists and business analysts.
Section 2.7 is devoted to illustrating a few of the
many applications of the derivative to the problems
of business and economics.

There are three main functions we will work with in

this section
Applications in our textbook are centered around
the theory of the firm.
We will study the activity of a business or industry
and restrict our analysis to a time period during
which background conditions (supplies, wage rates,
etc.) are fairly constant.

C(x) = cost of producing x units of a product

R(x) = revenue generated by selling x units of a
product
P(x) = R(x) C(x) = the profit (or loss) generated
by producing and selling x units of the product.
NOTE: These functions are often only defined for
nonnegative integers. Why?

Often, these functions give rise to a set of discrete

points on a graph.

In studying these functions, economists usually

assume that C(x) is defined for all values of x and
draw a smooth curve through the points.

If we assume that
C(x) has a smooth
graph, then we can
use the tools of
calculus
(derivatives) to
study it.

Suppose that the cost function for a manufacturer is

given by
C(x) = (10-6)x3 - .003x2 +5x +1000 dollars

In sketching the graph of the marginal cost

y = C(x), we can use y = C(x) to provide us with
information about the graph.

(a)Describe the behavior of the marginal cost.

(b)Sketch the graph of C(x)
For (a), recall that marginal is the word for
derivative in business and economics.
For (b), we can get information about the graph
from calculating first and second derivatives.

The relative minimum point of the marginal cost

graph can be discovered by examining
y = C(x) = 0.

We can tell that the marginal cost graph will be a

parabola that opens upward. How?

The graph of the marginal cost function.

Solving C(x)=.000006(x-1000) = 0 for x

uncovers a horizontal tangent at x = 1000.
The associated value of y in the marginal cost
graph is calculated by
(3)(10-6)(1000)2 - .006(1000) + 5
=36+5=2

Since the graph of the marginal cost function never

reaches 0, then there are no relative extreme points
in the graph of the cost function.

The graph of the cost function.

We also note that the graph of C(x) is never

negative. What does this tell us about the graph of
C(x)?
What else can we tell about the graph of C(x) from
looking at the graph of C(x)?

R(x) is the revenue received from the sale of x units

of some commodity.
We call R(x) the marginal revenue.

Revenue Functions

Economists use marginal revenue to measure the

rate of increase in revenue per unit increase in sales.
If x units are sold at a price p per unit, the total
revenue R(x) is given by
R(x) = xp

Some economic concepts for revenue

If a firm is small and has many competitors, then its
sales have little effect on the market price of its
commodity.
The price is then constant as far as the one firm is
concerned, and the marginal revenue R(x) equals
the price p.

However, if the firms production of a commodity

has a significant impact on the availability of the
commodity (for example, when the firm has a
monopoly), then an interesting problem arises.
Consumers will purchase more of the commodity
when the price is low, and fewer units when the
price is high.
Let f(x) be the highest price per unit at which all x
units can be sold to customers. Since consumers
will buy less when the price increases, the graph of
f(x) will be decreasing.

The demand equation p = f(x) determines the total

revenue function.
If a firm wants to sell x units, the highest price it can
set is f(x) dollars per unit.
The revenue function becomes R(x) = xp = xf(x)

The concept of the demand curve applies to an

entire industry, as well as a single monopolistic
firm. In this case, many producers offer the same
commodity for sale.
If x denotes the total output of the industry, then
f(x) is the market price per unit of output and xf(x)
is the total revenue earned by the industry from the
sale of x units.

The demand equation for a certain product is

We want to begin by developing our revenue

function R(x). R(x) = xp so

p = 6 x dollars
The marginal revenue is given by R(x)
Find the level of production that maximizes
revenue.
Note that R(x) is the graph of a parabola that opens
downward. How do we know?

We use R(x) = 0 to identify the relative maximum

point.

The graph of R(x) appears as

6 x = 0
x=6
The corresponding value of y is

Once we know the cost function C(x) and the

revenue function R(x), we can compute the profit
function P(x).

Profit Functions

P(x) = R(x) C(x)

Suppose that the demand equation for a monopolist

is p = 100 - .01x and the cost function is
C(x) = 50x + 10,000.
Find the value of x that maximizes the profit and
determine the corresponding price and total profit
for this level of production.

We need to construct the profit function

P(x) = R(x) C(x). C(x) has been given, so we
compute R(x) using the demand equation

The relative extreme point of P(x) will be the point

at which profit is the highest. We need to compute
the marginal profit function P(x), and solve
P(x) = 0 for x.

Then, our profit function is

Solving P(x) = 0, we have
-.02(x-2500) = 0
The graph of P(x) is a parabola that opens
downward. How do we know?

which yields x = 2500

If 2500 units are produced, the profit would be

P(2500) = -.01(2500)2 + 50 (2500) 10,000
= 52, 500 dollars
The highest price at which the 2500 units can be
sold is

Setting Production Levels

P = 100 - .01(2500)
= 100 25 = 75 dollars
Answer:
Produce 2500 units and sell them at $75 per unit.
The profit will be $52, 500.

Suppose that a firm has cost function C(x) and

revenue function R(x).
In a free-enterprise economy, the firm will set
production x in such a way as to maximize the profit
function P(x) = R(x) C(x).
If P(x) has its maximum at x = a, then P(a) = 0. It
follows that since P(x) = R(x) C(x) that
R(a) C(a) = 0 or R(a) = C(a)
Thus profit is maximized at the production level for
which marginal revenue equals marginal cost.